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We're obsessed with a letter and missing Europe's small print


Will the ECB slip the infamous letter through the letter box?

Will the ECB slip the infamous letter through the letter box?

Will the ECB slip the infamous letter through the letter box?

NICE timing, Frankfurt. The ECB promised, sort of, to slip that infamous letter from Jean Claude Trichet through the letter box; causing such excitement that hardly anyone noticed the postman himself had come crashing through the door.

That happened on Tuesday, when the European Central Bank took over the supervision of all three Irish-owned banks, AIB, Bank of Ireland and Permanent TSB, plus Ulster Bank.

It is a momentous change but has drawn hardly any political comment. That is being reserved for events of six years ago - more by the time the banking inquiry gets round to it, in which a letter whose contents are already largely known will play a starring role.

The present, and the future, are apparently of less interest, but one has to admit to a certain sympathy. Banking is dull. Dull, and extraordinarily difficult.

Thousands of people laboured mightily to produce the stress tests on Eurozone banks. The painstaking examination of tens of thousands of accounts seems to be the only way to thoroughly assess the state of the banks. So why are we not all out cheering because new teams of experts from the ECB will continually monitor our banks in future, so that nothing like this happens again? Apart from the lack of soundbites, there are difficult questions: will it work and what are the implications for the already opaque position of member states within the euro area?

Whatever the answers, it is certainly an important day in the history of the EU. In a new book on banking union published by the Institute for International and European Affairs (IIEA), analyst Pat McArdle offers the suggestion that it may actually be the most important development since the launch of the euro itself.

The Single Supervisory Mechanism (SSM), as it is thrillingly known in eurospeak, is certainly a major undertaking. The Irish banks are among 120 whose actions will be regulated, not from their home capitals, but from Frankfurt.

The inclusion of Ulster, a foreign-owned bank, is telling. Sean FitzPatrick's Anglo may have been largely responsible for instigating the mania in development lending, but the UK banks, Ulster (RBS) and Bank of Scotland (HBOS) bear much of the blame for the mortgage bubble.

The Irish government and regulator may have wanted to deflate it, but even if they did, they could take little action to stop the gallop of the British banks.

The Americans discovered the hard way (and then forgot) that inter-state banking is dangerous. The SSM does not look entirely convincing in dealing with the dangers.

Cross-border adventures are unlikely to be an immediate problem. The crash, like the prospect of being hanged, concentrated minds wonderfully and the SSM has already had a considerable impact. Some €200bn in fresh capital was raised by European banks before stress tests. It was also nice timing to have the SSM operational within days of the test results. Banks understood that if they failed, the new regulator would order them to find more capital. Many already had the process in train.

Some countries which are not in the euro are also keen to have the SSM regulate their banks. Nobody want a rerun of 2008. That is all fine and dandy - until the SSM tells a bank to do something its home government does not like, which could even include the winding up of a favoured institution.

Actually, in a small way, the issue has arisen here already. It was nice timing of the Central Bank to produce its rules on mortgage lending just before the SSM was up and running. But this kind of broad regulation, known as "macro-prudential", will remains with national regulators, although the actual demarcation lines seem hazy.

The reaction to the Central Bank's imposition of 80pc loan limits and income caps on mortgages was instructive. In the good old days (and not just in Bertie Ahern's time), the bank would have been quietly told by the Taoiseach's office to mind its manners, or the banks would have ignored the directive. Or both.

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This time, we can be quite sure Frankfurt will brook no interference or disobedience. So the Government said it would guarantee 10pc of the loan.

More than one commentator has pointed out that it means the taxpayer taking on more banking risk, but everyone seems happy because "it will help people buy houses". Now where have we heard that before?

We now have the SSM to make sure that banks do not go broke, and the EU commission to make sure that governments don't. That little episode, though unimportant in itself, suggests that both are needed, but there is a worrying potential conflict between the new powers of the EU institutions and the self-interest of national governments.

One striking thing about the SSM is the substantial role for the European Parliament.

The regulator will be answerable to it to a far greater degree than the ECB itself in the conduct of monetary policy. Since good banking regulation sometimes has to compensate for bad monetary policy, the trio of ECB, SSM and EP could find themselves in some very convoluted discussions. Despite the endless platitudes, no useful role seems to have been found for national parliaments.

The looming SSM not only spooked banks into raising more capital, it encouraged them to curtail new lending while reducing their existing loan books. Until now, there has not been much demand for credit either, but if recovery takes hold there will be, and banks need to be more confident about lending, and markets more confident about lending to them.

In their little duet last week, the Irish and German finance ministers skirted round the question of why the Eurozone is still languishing.

One could hardly expect them to say the one reason is lack of confidence in the workings of the monetary union, among banks, companies and households.

The stress tests and more credible regulation could well increase the potential supply of credit to finance a recovery. But it also needs to generate confidence for borrowers to look for more credit.

It cannot do that on its own but it might at least be a step towards unravelling the stalemate which has recovery dependent on confidence, and confidence dependent on recovery.

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